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Protecting Russia from the Collapse of Oil Prices Following the Mexican Scheme
July 23, 2020 00:50


Despite the fact that the prices for Urals oil are kept in the corridor of $ 40-45 per barrel, this is not very optimistic. Firstly, this level is still on the verge of a deficit-free budget. Secondly, the ghost of the second wave of coronavirus is walking both in Europe and in the whole world. The recovery in demand is noticeable, but reminds the famous story of Sisyphus  – he  drags a stone up a mountain, but at any moment it can roll down.

Therefore, the question of   a possible drop in oil prices is still relevant. One of the original ideas was the application of the experience of Mexico. We are talking about the creation in Russia of a mechanism for hedging oil prices on the model of this distant country. Putin's spokesman Dmitry Peskov has already confirmed that the president has given the task to work out the issue of using the so-called put options scheme for Russian oil.

The general public became aware of the financial technologies of Mexico during the heated negotiations on the second OPEC + deal in April 2020. Then Mexico resolutely refused to take on increased commitments to cut production, and as a result Trump promised to close 300,000 barrels of cuts for Mexico.

To insure against fluctuations in oil prices, the Mexican government buys oil put options, which give the right to sell oil at a fixed price after a while: for example, in 2020 this price is $ 49 per barrel of the Mexican Maya. The mechanism is simple: if the actual oil prices fall below that fixed in the financial contracts, Mexico profits from the difference between these prices. If the oil in the market is constantly trading above the hedged price, Mexico suffers losses in the form of the cost of buying put options. It looks a lot like futures.

Roughly speaking, you are buying insurance against falling prices. If the price falls below a certain level, you will be compensated for the loss.  For Mexico, with production about six times and exporting crude oil four times less than Russia's, this option costs about $ 1 billion a year. And with the arrival of Russian customers on the hedging market, this service will additionally rise in price.

Now imagine that Russia bought options, the oil price fell, and then the US introduced new sanctions against the Russian Federation. Then the big question is whether we will be paid the money we owe. So in addition to insurance against falling prices, you also need to buy insurance against new sanctions.

In addition, Russia already has a mechanism for insuring the risks of falling prices. And it is called... the National Welfare Fund. This is the main paradox of this story, because put options  are just proposed to be paid from the NWF. But in reality, the NWF logic has always been extremely simple. If the oil price is above a certain level - the same cut-off price - the NWF is filled. As soon as the price goes lower, the budget deficit is closed from the same NWF. Here's a simple and straightforward mechanism. True, the situation on the market now is such that we have to prepare for a long life at prices at the level of $ 40-45. But then we must honestly admit that budget expenditures will have to be cut and excessive spending should be forgotten.

In general, insurance against falling prices is used not only by Mexico. This mechanism is actively used in the United States. However, it is not the government that buys the insurance there, but the companies themselves. It is thanks to this scheme that many shale companies survive - they just hedge the risks of a decline in oil prices. It is completely unclear why this mechanism cannot be used in Russia as well.

It is not surprising that the Central Bank was the first to publicly oppose put options. 

And here it is worth remembering who proposed the idea with options. According to our press, Rosneft did it. The Central Bank and Rosneft have already sorted out the relationship on the topic “who collapsed the ruble” at the end of 2014. The simplest explanation why Rosneft came up with such an idea is that the company is in no hurry to ask for state support for itself or for the entire oil industry, since the government does not consider oil workers to be priority candidates for state support. In addition, Rosneft actively advocated withdrawal from the OPEC + deal, which ultimately led to a collapse in prices. But this does not mean that the head of the company Igor Sechin has revised his strategic views. 

And here you can see deeper intentions. Rosneft believed that without solving the problem of American shale, our prospects in the export market were not very impressive. Therefore, it was proposed first to solve the problem of expanding American oil exports. Rosneft may return to the idea of ​​a war with shale. Yes, Rosneft does not officially speak out on this painful topic, but the following logical chain can be behind the put option proposal: through hedging mechanisms, Russia can be prepared for a new decline in oil prices, which will no longer be painful for the budget. At the same time, the fall in prices should nevertheless cause the collapse of shale and the release of a niche in the market.

Author: Anna Dorozhkina

Tags: Russian oil Russian International Russian economy   

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